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An Inside Look at Venture Capitalists
Christopher Thomas writes: "IEEE Spectrum has a scathing review of venture capitalists this month. Authors Nick Tredennick and Brion Shimamoto paint a devastatingly cynical picture of venture capitalism from the engineers' perspective." Funny to read, but probably 100% accurate. Wow.
I can attest to this from personal experience: I am one of a small group of people to have received the (questionable) pleasure of being cold-called by a VC firm. It didn't matter to them that I was still finishing my BSc in mathematics; all that was important to the VC was that 1. Distributed Computing was hot, and 2. I was responsible for a recent distributed computing project.
Of course, calculating Pi isn't likely to be commercially profitable any time soon; for that matter, distributed computing isn't either. So I wrote back explaining that I had no intention of helping them waste their investor's money on ventures doomed to failure.
Ever since then I've refered to that day as "the day I refused five million dollars".
Tarsnap: Online backups for the truly paranoid
At my last startup, we were mostly funded by angels. Unfortunately, unscrupulous people in upper management took them to the cleaners. The upper management took worthless business trips to exotic locales, and bought extremely expensive office furniture. By the time we got the crooks out it was too late, the money needed to fund development and pay salaries was gone. Then the economy turned sour, and relations between the new management (who had been the old middle management) and the angels broke down. Personally, I felt bad for the angels, they had paid my salary for two years and given me a chance to be essential personnel at a company that had a viable business plan. If the con men hadn't eaten up all the money and left a husk, I might be making a reasonable (I never expected vast wealth) living now instead of collecting unemployment and the angels wouldn't have had to see their money tossed down a drain.
Trying to building a firewall without a uP was an exceptionally DUMB IDEA!
First you would have to build a real fancy state machine. TCP/IP protocols are based on streams of bytes/bits. Doing a couple of states in a parallel hardware design is easy, but thousands, or ten's of thousands of states is nearly impossible. Plus, a firewall needs to be flexible, (catch the latest un-expected hacker exploit, log it, etc), which is something most hardware designs are not.
Hence the idea of using Microprocessors is a very useful thing. B.T.W. What where they going to use to drive the I/O interfaces? All the designs I know of need at least one micro to run them! (I.E. Program dma lists, handle errors, etc). Unless you're going to re-invent those wheels as well, and build your own custom interfaces.
In summary, that idea deserved to die, it failed to reduce risks too an acceptable level!
The VC's were right not fund a real dumb idea, next time, pick a better example.
Seems to me that if you need a LOT of smaller companies, who make a SMALL profit to be able to hire a FEW developers.
What is happening is that VCs draw much money into very few supposedly LARGE companies in spe, who should make LARGE profits and still hire only a FEW developers, because they can overwork them. The smarter the engineer's and developer's ideas are, the more their ideas will minimize the development, implementation and maintenance costs. So basically their own inventiveness reduces costs for their own company they are working for, reduces costs for their customer's companies (to whom they want sell their idea) and all their brain work in the end is going to do is the reduction of costs for hiring developers and engineers. If that is not a tragic irony, I ask myself what is.
The architecture of the network itself seems to lead to few "large" companies. Very few "small" profit making companies are needed. OSS is highly desirable for non-for-profit organization therefore. The only way OSS can really be funded and developers hired en mass, is by support from the government. It's a shame that OSS is not used in all educational institutions.
The monopolization is a process, which the current laws don't prevent from happening adaequately.
If I were an engineer, I wouldn't care, if I work for a large company or a small one, as long as I would believe in the product I am developing and as long I am decently paid for by the company to provide for my family. That's what apparently is not happening for too many engineers and developers, because midsize and small companies can't pull through more than a few years before they have to sell themselves out to the big guys, who most probably won't hire all of the small company's engineers and developers.
I was always wondering if the funding mechanism for companies like SuSE was different than the process described in the article. Even if SuSE lacked money lately, they did seem to grow more organically out of themselves. I would be interested in understanding, if there is a major difference (legally or culturally) in how privately held companies are formed and funded in Germany vs. the U.S.
Needless to point out that I don't know what I am talking about, but I try to listen as best as I can.
To be fair, some VCs do recognize this and do something about it. I have a friend who's been involved in a few startups. Not too long ago he described what had happened in one funding round. BTW, you're practically always involved in some sort of funding-related activity or another, all day every day. If you're a true techie you'll go insane wishing you could sit down and write code again. Anyway, this is basically what the lead VC said:
What ended up happening is that some of the previous-round investors saw their share reduced so the founders' share could be increased. I'm sure they didn't like that much, but I'm also sure that if it was presented as a choice between that and losing the lead investor (with nobody else ready to step in) they would have gone along. Losing the lead investor like that at that point in time would basically have meant that the company had zero prospects of survival (in fact it did not survive).
The upshot is that a "vulture capitalist" really - for once - did try to do the right thing by the founders, and even leaned on other investors to make the right things happen. They're not evil people. They're ambitious, they're greedy, they're often ruthless, they almost always have goals that are at odds with techies' goals, but they do have honor.
I wish I could name the east-coast VC company involved, because I like to see good behavior rewarded. Unfortunately, I don't feel safe doing so. One character trait they hold very dear is "discretion"; it's not very discreet to tell stories like this one in a place like slashdot, and I might want to do business with them myself someday. ;-)
Slashdot - News for Herds. Stuff that Splatters.
I'm not going to report to a boss after taking this long to become my own boss.
You always have a "boss". Be it your business partners (who boss you and whom you boss) or your customers... there is someone that you are ultimately responsible to...
One question I have is... is it truly ethical to use a non-profit organization as a front for your for-profit business venture?
You probably won't have much chance for 501c3 status unless you completely separate the two businesses... better to stick with a for-profit. Starting a non-profit is hard work, and not something that should be taken lightly... or with expect for anything but a trival return on your time investment.
I'm convinced that most startups don't need venture captial. What they do need is a core crew of engineers and (later on) a skeleton crew of support staff (ie, people who will find paying customers) who are willing and able to take equity instead of cash until paying customers are found. When and if those paying customers are found, profits not reinvested in the company are paid out as dividends to the shareholders. Add angel investment into the mix as appropriate. Don't even consider going public (not worth the overhead and distraction, especially now that the IPO bubble has gone kaboom), but if the stockholders (mostly engineers, if you've managed to do this right) want to sell out to a Big Company that offers the appropriate pile of lucre, that works too. (A local crew did this, selling out to Cisco for $millions. Neat trick.)
Benefits:
1) Paying out cash to employees is inefficient, since the marginal tax rate in America is roughly 50% (28% Federal income + 12.4% SocSec + 2.9% Mediscare + the state income tax that pays for the roads/schools/fire/police that people actually use). This is known as "soaking the rich", aka slavery, aka how the Democratic Party has adapted from the pre-Civil-War era to the Information Age. Equity doesn't get taxed until it's sold, and the long term capital gains tax is 20%. Which is why the 1993 Federal income tax hike didn't kill the economy, people just switched to financing with stock instead of cash, which had the unfortunate side effect of making it easy to fund things like pets.com.
2) Very little corporate overhead, very simple. Minimizes contacts with lawyers, accountants, and other such creatures that add friction to the economy.
Problems:
1) The U.S. Federal Tax Code is rigged to royally screw companies that pay out dividends. Corporate profits are taxed once as income, and the stockholders are taxed again on what's left of that income when they receive their dividends at the stockholders Federal income tax rate. So $1,000 in gross profits becomes $650 in net profits becomes ~$450. Possible workaround: profit-sharing checks for the employees, but that doesn't help angel investors if you have them. Killing the double taxation of dividends would make more sense but it would never get through the Senate.
2) Surviving on little to no income while the company gets off the ground. Even without dependents, just paying for housing is a bitch, and geeks tend to congregate in territories with the looniest real estate valuations. (In the Midwest, that means my home city of Ann Arbor, Michigan, home of the University of Michigan, with housing valuations second only to Chicago.) The reason valuations are so high is that the Federal Mortgage Interest Deduction encourages real estate inflation, and the average voter is too stupid to realize that giving up their precious deductions (aka social engineering) and switching to the Flat Income Tax plan would leave them at least as well off. Local zoning regs that make high-density development impossible do the rest (thus why we have yuppie lofts in renovated decrepit downtown buildings renting for $big bucks rather than highrises).
3) Stock is much riskier than cash for workers. Nice upside when it works, though.
4) This doesn't work for companies with heavy capital expenses. Fortunately, many/most geek companies don't fall into this category.
Fair warning: IANA(lawyer | accountant), just a geek who follows finance and politics enough to be dangerous.
I agree with the comments above, but there doesn't seem to be an understanding of WHY VCs are so vulture-like.
It is really very simple. There is no such thing as a "win-win". Or rather there is no reason why a win-win has to be 50-50.
When dollars are on the line, it is a zero sum game. What the VC gets, you don't get. What you get, he doesn't get. What he doesn't get, his investors don't get.
If you were an investor in a VC fund, you would want that guy chiseling every percent he could from the companies he funded. As the entrepreneur, you want to chisel every percent for yourself. Both sides are justifiable and equivalent.
It's nothing personal.
"The difference between theory and practice is small in theory and large in practice..."
This article entirely misses the point of VC. VC isn't out for you or your company, they are out for themselves, and if that means they leave a body count behind, it's just part of the business.
the VC's goal in investing is increase his money immensely. Just like a lot of folks had as a goal when they dumped untold millions on Power Ball or the Big Game. Start Ups are VC's version of the lottery, and just like when I lost powerball, both toss the ticket when it's clear it's a looser. (and since these are folks who if they loose a few dollars aren't going to miss a meal, it's little emotional investment for them to toss you and your company)
Just like a loan shark, expect unreasonable demands, exhorbitant interest rates, and an indifference to anything but getting their money back and the expected rate of return... since VC is a little more than legal loan sharking.
As a founder it's in your best interest to be very very clear on this before you sell your soul to the devil. My suggestion for an education is go look up the reference to Mark Twain's Republic of Gonder... walking in assuming these people are interested in anything more than their money is just poor thinking.